Trane Technologies plc (TT) — Q1 2020 Earnings Call Transcript

Thanks operator. Good morning. And thank you for joining us for Trane Technologies First Quarter 2020 Earnings conference call. This call is being webcast on our website at tranetechologies.com, where you will find the accompanying presentation. We are also recording and archiving this call on our website. Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Please see our SEC filings for description of some of the factors that may cause our actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures which are explained in financial tables attached to our new release. Joining me on today's call are Mike Lamach, Chairman and CEO; Chris Kuehn, Senior Vice President and CFO; and David Regnery, President and COO. With that please go to Slide 3 and I'll turn the call over to Mike. Mike?

Thanks, Zac, and thanks, everyone, for joining us on the call today. Under normal circumstances, I'd start today's call with a brief overview of our global business strategy and how that's enabled us to deliver strong financial results to our shareholders. But today, we're living through anything but normal times. So suffice it for today's call, although we've got a new look and feel under our new Trane Technologies branding, our long-term strategy is unchanged. With that in mind, I'm going to move directly to Slide 4 and into the heart of our presentation today. The focus of our call today is less about earnings in the quarter or even in 2020 and more about the long-term health, strength and positioning of Trane Technologies as a pure-play climate control company, business conditions adapt and eventually improve in a post-COVID-19 world. The depth and duration of the downturn and subsequent recovery is a multifaceted equation that's impossible to solve. None of us have ever experienced anything like this in our lifetimes. And we can't effectively draw conclusions from historical reference points because there aren't any. Social distancing has never been part of our recession vernacular and it provides layers of complexity to our daily life that has far-reaching personal and professional impacts that we are learning about and trying to adapt as we go. And for some, these impacts are more devastating and personal than others. As a global leader in our field, working with thousands of customers and suppliers and touching the lives of exponentially more people, how we lead through this crisis and the things we prioritize matter deeply. The implications of leading companies' actions are far-reaching. A major employer acting with a singular short-term profit focus can take down the community. A community can take down one or dozens of companies and the unintended consequences can keep rolling downhill exacerbating an already very challenging situation. We strongly believe the right course of actions for our employees, our customers and shareholders is to lead authentically, steadily and with a sense of purpose. We will remain true to our strategy, maintaining world-class employee safety, acting with uncompromising ethics and integrity, supporting the communities in which we live and work, and steadfast in our commitment to building a more sustainable world. Due to the fundamental building blocks that drive sustainable, differentiated financial performance for our shareholders now and in the long-term. With this context in mind our core operating principles through this downturn are clear. First, protecting the safety and security of our people is paramount. And here I'll start by saying that we've retained more than 95% of our talented workforce annually for over a decade. And a strong and talented employee base is the most important factor in creating great customer experiences and shareholder returns. We have benchmark levels of employee engagement which is core to our culture and values and this is a differentiator that is often overlooked. Each time we survey our employees, the top three things that our people identify with are our culture, engagement, our sustainability purpose, and the belief that one company can change an industry and an industry can change the world. Second, it is the ethics and values we live and lead by, and third, it's safety. In fact, with regard to our safety record, I don't know of another company today with a better safety record than our own within or anywhere outside of our industry. Safety and respect for others are at the core of our value system. We went into the downturn as the premier climate control company, and our relentless focus on continued high employee engagement will enable us to emerge on the other side of this downturn even stronger. Since the crisis, we've gone to great lengths to keep our people safe across the globe. It's not just about strict PPE protocols, dramatically increasing cleaning and disinfecting; we are implementing employee after-screening and safe distancing protocols. It is about fundamentally rethinking the way tens of thousands of people conduct their work in our offices, factories and warehouses and reconfiguring them for safe distancing through actions such as reconstructing and rebalancing production lines, radically adjusting material and workflows, and investing in new equipment to adjust for new lifting and positioning requirements. And in every facet of how our people work and move throughout our facilities. We’re also actively helping our employees and communities with financial assistance through this challenging time, through supporting national and local community organizations and through our employee-funded Trane Technologies Helping Hands fund. We’re in a strong financial position with a solid balance sheet and liquidity, and we’ll continue to generate powerful free cash flow. We will utilize our strength to play aggressive offense throughout the downturn. We have a strong management team, a proven operating system, and confidence we can execute our downturn scenario playbook to limit decrementals in line with our gross margins. We announced the RMT transaction of Gardner Denver early in 2019, and by mid-2019, well ahead of the pandemic; we created an office of transformation that reports directly to me. Blueprinting the organizational design and developing transformational margin improvement opportunities for the pure-play Trane Technologies of the future. The stack of projects relating to these margin improvement opportunities are progressing well and many are underway. We’re looking forward to discussing these opportunities in detail on the Analyst Day which is still slated for the fall, whether that’s in person or virtually. The transformation office also oversees stranded cost reduction programs, and this downturn has created opportunities to accelerate the elimination of stranded costs. We have now identified $90 million in permanent structural cost savings that we expect to take effect in 2020 with run rate savings in 2021 of $110 million. Lastly, I personally find it useful to continue to look at the future through a holistic sustainability lens. First, sustaining the health, welfare, personal development, and future of our talented people around the world. Next, keeping our communities safe, healthy and thriving. And finally, of course, business sustainability which means managing the business for the long term, including the opportunity we have to invest and build our capabilities even in this downturn so we can emerge with an even wider competitive advantage. We have a tremendous opportunity to make this happen. In fact, looking back at the last downturn in 2008, we couldn’t be in a more different and preferential position compared to then and better suited to capitalize on advantages. Now let me turn the call over to Dave to discuss COVID-19 and our proactive response to the crisis in more detail. Dave?

Thanks, Mike. Please go to Slide 5. During the quarter, the impact of the COVID-19 pandemic changed the economic landscape in an unparalleled manner. Moving from region to region, it impacted our employees, customers, and communities as it spread. At Trane Technologies, we began in early January forming crisis management teams to confront the pandemic with employee safety as our number one priority. As we moved into February, we closed all our facilities in China and proactively began addressing employee safety. As Mike alluded to on the previous slide, the safety measures were more than just providing PPE. We took a holistic look at how we work. Our teams proactively reconfigured our facilities to address the pandemic. We changed the way production lines flow, replaced machine operators, and created physical barriers where necessary. We implemented active screening, staggered break times, and increased the frequency of cleaning measures. By March, as we ramped up production in China with protective measures in place, the work of reconfiguring our facilities moved to EMEA and the Americas. We proactively sent employees home and ensured their pay would be held whole to reduce the number of employees in our facilities, to deliver essential customer orders only. This increased safety for our employees and greatly reduced our facility output to provide time to implement the necessary safety measures fully in each facility. To be clear, these safety measures were not limited to our plants. We proactively addressed employee safety in our distribution centers, offices, and parts stores. All facilities were in scope. By the time April began, our plants in Asia-Pacific completed their ramp-up, and our plants in EMEA and the Americas began to ramp their production. We expect most plants would be fully ramped early in May. Throughout the quarter, our supply chain crisis management team proactively worked with our suppliers as they address their own COVID-19 challenges. The team continues on a daily cadence to manage potential risks. This team has done an excellent job. As we move into May, we are running with new line rates and protocols and adjusting to meet customers’ demands. Please go to Slide 6. From the start, Trane Technologies has been addressing the crisis by bringing expertise, technology, and services to their critical applications for hospitals and other healthcare facilities like clinics, research laboratories, and pharmaceutical production. By ensuring proper air treatment, filtration, ventilation, and decontamination, we’re helping to keep patients and healthcare workers safe and more comfortable in the most challenging situations. We are providing and maintaining indoor air quality through solutions such as Trane catalytic air cleaning systems, which remove pathogens from air streams, and negative pressurization systems to isolate infections. Our remote monitoring controls and building intelligent solutions are increasingly important in an environment of social distancing. These technologies enable technicians to remotely monitor, inspect, and troubleshoot systems to keep critical environments running safely and efficiently. Our Transport Refrigeration Solutions are protecting the cold chain and helping to ensure the safe and reliable delivery of perishable food, medicines, and other critical goods. Through telematics, we're putting data to work with the ability to track and trace deliveries across fleets, monitor the location of assets, and the temperature of individual deliveries in transit. Please turn to Slide 7; Trane Technologies has been addressing the impact of the pandemic on our communities. Established a number of years ago in response to natural disasters and funded by donations from our own employees, the Trane Technologies Helping Hand Fund is providing financial assistance to our own team members around the world dealing with financial hardship as a result of the pandemic. According to our Feeding America partners, food donations in this environment have declined by nearly 60%. In response through our Trane Technologies Foundation, we made a $100,000 contribution to Feeding America. And our team stepped up to help out with the effort. In one example, our Thermo King and Commercial HVAC Americas team joined forces with Feeding America and a hand-up initiative to host drive-through pantries in Lynn Haven, Florida, providing more than 120,000 pounds of food to nearly 6,000 people. Additionally, teams are upgrading operating rooms, air handlers, preparing patient isolation areas, and expanding COVID-19 treatment facilities for hospitals in record time. I am proud of how our team focused on employees’ safety and supported our customers and communities in response to this crisis. And I am confident they will continue to address the challenges presented by the pandemic as we move forward. And now I’d like to turn it over to Chris to discuss our balance sheet and liquidity position. Chris?

Thanks, Dave. Please turn to slide number 8. As Mike mentioned, at the outset of the call, we are operating from a position of financial strength as we move through uncharted territory in 2020. We have a strong balance sheet, excellent liquidity, and have maintained solid investment-grade ratings over many years. Additionally, our consistent track record of delivering free cash flow of equal to, or better than, 100% of adjusted net income over time, with a five-year average of 107%, including an outstanding year in 2019, which delivered 118%, further bolsters our strong financial position. The timing of the close of the Reverse Morris Trust transaction with Gardner Denver, on February 29th, 2020, and the receipt of $1.9 billion in cash also provided significant liquidity, owing to the rapid pace at which both organizations tirelessly worked to finalize the transaction in 10 months’ time. That money has been received and is reflected in our March 31st cash balance. In addition to cash on hand, we have full access to our revolving credit facilities; the first $1 billion facility expires in March of 2021, and we expect to refinance this prior to maturity; the second $1 billion facility matures in April of 2023. Even if we were to fully utilize both facilities, we would remain well below our primary debt covenant of 65% debt to capital. Both facilities were undrawn at March 31st and remain undrawn today. Lastly, we run a relatively CapEx-light business model, so our capital requirements are pretty modest at around 1% to 2% of revenues. Now, I’d like to turn the call back over to Dave, to provide details and color on what we saw in our end markets in the first quarter. Dave?

Thanks Chris. Please turn to slide number 9. Broadly speaking, our HVAC markets remained healthy in the first quarter, with pre-pandemic bookings and revenues largely in line with our full expectations. As the pandemic progressed across the globe, bookings and revenue were heavily impacted, first in Asia-Pacific followed by EMEA, then the Americas. In each region, our proactive safety measures temporarily limited our uptime and our utilization. Despite the pandemic, our commercial HVAC Americas business delivered strong broad-based growth with bookings up mid-teens and revenue up mid-single digits. We saw strong demand in datacenters and from institutional customers across education, government, and healthcare. Our residential HVAC business also saw strong demand with bookings up mid-single digits. With strong bookings growth in commercial and residential Americas, HVAC backlog was up double digits versus first quarter of 2019. The majority of the backlog consists of applied systems which typically have lead times of 6 to 12 months. Our transport business was heavily impacted by the pandemic in each region, accelerating declines already expected from the correction cycle that began last year; I'll give a more detailed update on our transport business later in the presentation. With the COVID-19 pandemic impacting EMEA for most of March, our team saw low single-digit declines in both bookings and revenue. Despite the pandemic, Europe commercial HVAC bookings and revenue were up low single digits. During the quarter, Asia-Pacific was hit first and hardest by the pandemic with bookings and revenue down double digits. Given the pervasive impacts of the crisis, I'll give additional insights to our end markets later in the presentation based on order patterns we saw in the month of April. And now I'll turn it back to Chris to discuss the results for the quarter. Chris?

Thanks again, Dave. Please go to Slide 10. The onset of the COVID-19 pandemic significantly impacted our first quarter financial results as we took actions to protect employees and customers. As Dave mentioned on the previous slide, prior to the pandemic, our global revenues in the first quarter started off largely in line with our full-year expectations. However, pandemic impacts limited our global equipment and service revenues by approximately $150 million in the quarter, with almost two-thirds of the impact in Asia-Pacific contributing to our 5% organic revenue decline. Adjusted EBITDA margins were down 60 basis points in the quarter primarily due to margin impacts from the volume declines related to both the pandemic and the transport correction cycle. Negative product mix in the Americas more than offset positive price versus cost. As we delivered mid-single digit revenue growth in commercial HVAC as compared to approximately 30% revenue declines in transport. We implemented proactive cost controls across the business and accelerated our stranded cost reduction actions, contributing to a $16 million reduction in unallocated corporate costs and positive productivity versus other inflation in the quarter. Please go to Slide 11. During Q1, we delivered enterprise deleverage within gross margin rates on lower volume by managing all elements of the P&L including our decisive actions to accelerate cost reduction programs. Within the Americas region, our transport revenues were down approximately 30% as the correction cycle in the end markets was accelerated by the pandemic. Americas margins were heavily impacted by both the volume and mix impacts of the transport revenue declines. Given the size of our Americas operations, our commitment to proactively invest in employee safety and security in our plants, distribution centers, offices, and parts stores added necessary costs and reduced absorption in the quarter, negatively impacting margins. Margins in EMEA and Asia-Pacific were both impacted by top-line headwinds related to the pandemic. In each region, swift action and strong execution of cost reduction programs limited deleverage to within gross margin rates. Please go to slide 12. As Mike discussed in his opening remarks, given the onset of COVID-19, we're aggressively stepping up our efforts to remove $100 million in stranded costs related to the reverse Morris Trust transaction we closed in Q1. After announcing the transaction in April last year, we quickly mobilized a margin improvement and transformation office by mid-summer to focus on these cost reductions, which gave us a nice head start in determining the best, most value-accretive ways to eliminate these costs while simultaneously improving the overall capabilities and margin expansion opportunities across our businesses. We quickly moved to implement zero-based budgeting processes and principles across the company. Entering 2020, we set a cost reduction target of $40 million in a year of the total $100 million in stranded costs. We looked for opportunities to accelerate the pace of savings in the first quarter and with the onset of COVID-19 saw an opportunity to push ourselves further. To date, we've identified savings of approximately $90 million to be realized in 2020, more than double our original target. Further heading into 2021, the actions we will have taken in 2020 should yield permanent run-rate savings of approximately $110 million in 2021. Of the total $90 million savings in 2020, we expect about $70 million to come from corporate unallocated expenses and approximately $20 million to come from the segments. Lastly, we previously disclosed we would incur one-time costs of approximately $100 million to $150 million to permanently eliminate the $100 million in stranded costs, and the table on the bottom right of the slide shows our status to date. We spent approximately $31 million in Q1; we will update you quarterly on our progress. Please go to slide 13. We remain committed to balanced capital deployment going forward as we have consistently done for many years. Given the unpredictability of the depth and duration of the downturn related to COVID-19, we wanted to highlight the modest adjustments we have made for 2020 and equally important, highlight the things that have not changed. As Mike outlined, we are going to manage through this downturn from a position of financial strength. We see this as a time to lead and a time to aggressively invest in our most important asset, our employees. We also see this as a time to aggressively invest and to solidify or extend our market-leading positions through value-accretive investments that will make us an even stronger company coming out of this crisis than when we went in. Importantly, we expect to maintain our dividend at current levels for 2020 and have already paid the quarterly dividend for the first quarter and declared the quarterly dividend for the second quarter. We expect to pump the brakes on share repurchases in the second quarter, while maintaining optionality down the road. Regarding debt obligations, we committed to and paid $300 million in April to retire debt at maturity, and we expect to pay down the next debt obligation of $300 million at maturity in February of 2021. We will continue to evaluate strategic value-accretive mergers and acquisitions. Lastly, we expect to maintain a strong investment-grade credit rating. This offers us continued optionality as markets evolve. And now I'll turn it back to Dave to give an update on current Q2 trends. Dave?

Thanks Chris. Please go to Slide 14. During the month of April, we've seen global orders down approximately 20%. Looking across the regions, orders in the Americas and EMEA were both down over 20%; Asia-Pacific orders were also down but under 20% as China demand is near prior year levels. Given the normal seasonality of our business and continued deterioration in economic indicators, it is unknown whether these order trends will further deteriorate, stabilize, or improve. In the Americas, demand for our commercial applied products has been more resilient, particularly for essential end markets including warehousing, datacenters, and healthcare. Unitary demand has been softening. Broadly speaking, during a downturn, our service and parts businesses typically see strengthening demand as customers choose to extend the life of their HVAC equipment rather than replace it. Since this downturn is driven by a pandemic, traditional HVAC services and parts demand have been limited due to access constraints at customer sites. Conversely, the pandemic has driven additional demand for our intelligence services, which include remote building monitoring and indoor air quality offerings. In the residential market, approximately 80% of our sales are replacement units. Impacts from the pandemic have caused declines in consumer confidence and increases in unemployment, our two main replacement market indicators. Though the overall demand is down, we are seeing orders for both lower SEER products that appeal to value customers and higher SEER products that appeal to customers looking to improve indoor air quality as more people are working from home. I'll speak about our transport market outlook on the next slide. Our EMEA markets are seeing similar disruption to what we are seeing in the Americas with France, Italy, Spain, and Portugal being significantly impacted. In Asia Pacific, China demand is near prior year levels, while market demand in India, Singapore, Malaysia, and Japan remains restricted. From an operations standpoint, we continued to proactively invest in employee safety across our facilities. Our plants in Asia have ramped up, and our Americas and EMEA plants are ramping as we speak. Since China was the first area to be significantly impacted by COVID-19, we have received questions asking what lessons we've learned from our efforts in this region. Our number one learning was that early proactive safety measures are absolutely paramount, and we have rolled out these measures globally. Second, consistent focused supply chain cadence is critical to support equipment production and service delivery. Those processes have been effective and implemented globally. And our final learning is that no two countries are the same. At this stage, it is unclear if other countries will track to a similar recovery path as China, given the varied regional responses to the pandemic. Finally, as we highlighted in our earnings release this morning, we are temporarily suspending our formal guidance and expect to re-evaluate for Q2 earnings. Please go to Slide 15. COVID-19 has created obvious disruptions in the majority of our end markets as outlined on the prior slides. The near-term impacts on the transportation markets have been even more significant. On our Q4 call, we provided a good level of detail on our expectations for the transportation market in 2020. Today, I would like to dive a little deeper and provide market forecasts for North America and EMEA for each of the major product categories with truck, trailer, and APU broken out separately. The COVID-19 impacts on the transport markets in 2020 are pronounced, with dramatic forecast reductions across all major product categories in both North America and EMEA. For North America, the trailer forecast has dropped from down 25% in January to down 46% as of a week ago. The North America APU forecast has moved from down 33% to down nearly 60% for 2020, while the truck forecast has dropped from down 3% to down nearly 20%. Likewise, Europe truck and trailer forecast declines have nearly doubled as well. Additionally, while we don't have the same level of reliable detailed forecasts available for the other businesses, including marine, bus, and rail, these markets are down similar numbers as well. As you might expect, COVID-19 has dramatically slowed global demand in food distribution, which supports hard-hit businesses like restaurants. Long-haul trucking has been significantly impacted by the slowing of the overall global economic demand and cross-border shipping. Aftermarket parts are showing resilience, and demand is expected to continue to be solid, as companies look to extend the life of their existing fleets. In terms of the timing of the pandemic impacts on transport, we're generally seeing encouraging booking rates through the first two months of the year that supported our initial transport outlook for 2020 that we provided on our fourth quarter earnings call. As we moved through March and the pandemic started shutting down major portions of the economy, booking rates dropped significantly consistent with the updated forecast view on the slide. Today in April, we're seeing very slow bookings, as most trucking companies have hit the pause button on activity to reflect the significant downturn in the economy and across major sectors of the refrigerated truck, trailer, and APU markets, as I discussed earlier. The forecast for the second quarter for North America trailers, for example, is down approximately 80% from 2019. April-to-date, our bookings across Transport Americas for equipment are down about 80%, which is consistent with that outlook. While aftermarket is relatively flat with prior year. The ACT forecast has been revised lower several times since the pandemic hit, so it's really too early to call how 2020 ultimately will play out. As states reopen and economic activity gradually returns to normal, we expect demand to significantly pick up from current levels as well. ACT initially called for a market correction in 2020 and then a return to growth in 2021, and that still seems directionally correct, although COVID-19 impacts are likely driving a deeper and more prolonged market correction and a more cautious and gradual return to growth. And now I'll turn it back to Mike.

Thanks, Dave. Please go to Slide 16. Our strong financial condition, balance sheet, and liquidity enable us to operate from a position of strength throughout the COVID-19 crisis. This has been demonstrated through two significant revenue downturn scenarios: the first down 15% and the second down 25%. And to reiterate, because I've heard there has been some confusion in other company earnings calls, these are not our forecasts; they're just scenarios. We want to have a response under any scenario, given the tremendous uncertainty that exists in the near-term. We also want to assuage investor concern by showing a breakeven free cash flow analysis in the minus 25% scenario. It's important to note, however, that in both scenarios, we have the financial strength to weather the storm, pay dividends, and continue to follow our core principles. We are going to remain true and uncompromising to our purpose-driven sustainability strategy and our core values, including employee safety and well-being and corporate citizenship in our communities. Anyone who knows our company and our culture knows that this is something we believe in at our core: it's who we are, and it's how we win. It's what has driven strong shareholder returns over the past decade since the last downturn and what we believe is a proven formula for sustainable, strong shareholder returns in the future. We're also going to play aggressive offense. We see this downturn as an opportunity to invest, expand market share, extend our leadership as the premier climate control company, and emerge from the crisis even stronger than when we went in. We're going to continue to execute our playbook and take appropriate cost actions. We are going to be very strategic in our application. Our objective isn't to maximize 2020 earnings; it is to build a Trane Technologies of the future and to win big over the long term. Please go to Slide 17. Our long-term strategy remains unchanged, and it's underpinned by strong secular sustainability mega-trends. Our end markets, our strategy, and our products and services are all tied to the undeniable fact that the world is getting warmer, cities are becoming more densely populated, and the demand for fresh food is accelerating. Fundamentally, we excel as these global mega-trends and sustainability intersect with our innovation and capabilities which drives high demand for our products and services. While short-term demand may be impacted or pushed out, longer term, the challenge is that the secular mega-trends present will not abate and require leadership and action post-COVID-19. We also know that the post-COVID-19 world will evolve and adapt to the new reality and experiences we've gained through this crisis. Accurate design, installation, service, and monitoring of HVAC systems will be more important than ever to ensure proper filtration, ventilation, air flows, and pressurization in high-density areas and especially in critical environments like hospitals, food and pharma, office buildings, hotels and homes, buses, and other modes of mass transportation. Remote monitoring, diagnosis and artificial intelligence-based service models have the potential for exponential growth and new service models will emerge. These are just a sliver of the potential opportunities we see now and we intend to evolve, adapt, and capitalize on them. In the near-term, we strongly believe it's imperative that premier companies like Trane Technologies lead through this crisis authentically, steadily, and with a sense of purpose. We will remain true to our strategy built on the fundamental building blocks that drive sustainable, differentiated financial performance for shareholders now and in the long-term. We also see this downturn as an opportunity to invest, expand market share, and extend our leadership to emerge with an even stronger culture and a stronger company than ever before. Even in the current crisis, we're confident and excited about the future of Trane Technologies, and our ability to bring all of our considerable resources to bear to deliver strong, sustainable returns for our shareholders. I want to thank our dedicated employees around the world for supporting all that is essential to fight this pandemic and all the frontline caregivers that are heroically battling for all of us every day. And with that, Chris, Dave, and I'll be happy to take your questions.

Hi, guys. Good morning. Hope you can hear me, okay? Good morning, thanks for the detail. It's super helpful, but I'm kind of intrigued by this whole indoor air quality theme overall. And I guess the question really is what did the building owners care? Is there a sense of urgency outside of obviously hospitals have always cared? But when you think of the other categories that you sell into, is your phone lighting up that people say, wow, we need to do a retrofit project here or is it just too early to really say?

Yes, Scott, it's too early to say, but we're looking at just sort of human behavior and the lasting effects of what a pandemic would do to society, and we see a little bit happening through our lens in China, although you can't draw exact parallels between the two. One thing for sure is that the ability to really monitor your indoor air quality and to design and make sure that from a maintenance perspective, and all the controls and automation that go into making sure that it's effectively working, I think you're going to see sort of more density per square foot of all that and perhaps codes that in some parts of the world, which may have not been up to high standards might change going forward, as well as food transportation codes and standards. So probably when you get through this, it puts an importance. And I think particularly as buildings become tighter and tighter in terms of their design, I am talking about the envelope of the building, it’s so critical to make sure that you’re having fresh air exchange in the building; a typical building, depending on what it does, might have half a dozen to dozens of 100% air changes in an hour. And the ability to make sure that’s happening and that you’re killing pathogens in your system, or you can, or pressuring appropriately or diffusing air, or diluting air is going to be even more critical. So I think it bears a lot of opportunities going forward. I mean, it's hard to call what will happen right now, but I think the opportunities will likely be greater than not.

Okay, good. And then I am just kind of curious about the confidence you have in your backlog. I would assume that 7% of your backlog includes things like hotels and stuff like that, that I would think risk not just delays but cancellations as well. So perhaps just a sense of what your confidence in the backlog is overall.

Scott, this is Dave. So we’re pretty confident in our backlog, especially in the HVAC space; a lot of it is in the applied world. We haven’t seen a lot of cancellations there; in fact, we actually haven’t seen many at all; it’s pretty normal. Our TK backlog is a little bit more concerning as we have seen some cancellations, but it's pretty low right now. So overall, I’d say we’re pretty confident around the globe in our backlog, and we haven’t seen anything that would lead us to believe that won’t happen.

Yes, Scott. If you think about, you mentioned hotels, but you could also consider retail. That’s a small part of our business; I mean, retail is an example. We’ve never focused much on national accounts at all, as an example. And so if you think about our relatively high share in unitarily and light unitary, the smallest share by design we would have would be in retail. And if you go into hotels, the place where we play in hotels is sort of in the lobby and in the common areas. And in the larger and more complicated spaces, we really don't play in sort of individual rooms. And so the vacancy of a hotel isn't going to matter; if the hotel's open, we're going to be providing equipment and services. So that is a little different; maybe a decade ago I would have said we would have had more focus on retail and national accounts, and that's changed over the decade.

Thank you. Good day everyone. Yes, my pleasure. Just first on the kind of working through these scenarios and what you're planning to do. Just want to be clear. The comment about managing the decrementals around gross margin would require extra actions. Are you planning to take those actions? Are you suggesting to us that none of us has a crystal ball, but pick our revenue scenario and we should expect your decrementals to be around your gross margin rate?

Yes, that's a great question. And the first thing I would tell you is that, anybody that thinks they're going to forecast a number is only going to be surprised when the forecast meets the real world the first minute. The notion of really doing scenario planning is something that we've been living with for a long, long time. And although we would have done scenario planning in the past, it would have been around a general recession. So a pandemic is something new with regard to just the behavioral changes in the way that say in our case buildings would even be closed or limited in terms of access for service. The pandemic offers a different scenario now; we also think through to Scott’s earlier question, where the opportunities lie going forward. It's more useful just to think about scenarios and what happens as we move through this recession. So, for us, we've looked at, I would say in increments of five points of revenue decline. One of the series of actions that we would need to take on top of those actions we've already taken is having a playbook in place to do that and give us confidence that we can maintain a reasonable gross margin. Detrimentals would be in line with that. But in doing that, we don't think there's an opportunity to double down in areas of innovation or doubling down in areas of productivity. The key to this for us is, we entered this situation with a pretty wide gap relative to some of the competition, and we want to come out of this with an even wider gap. We've never been in a better position regarding liquidity, talent, and technology to be able to do that. So, it would be a tragedy not to really invest but also manage the decrementals while continuing to double down on important investments for growth and productivity.

As an unrelated follow-on second question. Mike, you mentioned M&A kind of prominently in your comments. Can you give us a little thought on what you're interested in and the priorities for the new company on a standalone basis here?

Yes, it's always the strategy that needs to drive M&A. And so, the idea is that we would see 80%, 90% of the ideas that we have would be defined by the strategy; that hasn't changed around technology and channel for us, and they tend to be in buckets. It's the easy bolt-on technologies that need a channel, or it's the channel that adding our technology would make that channel work better. Those are easy for us to do. I would tell you that we remain very active in this area. Some of the larger, more transformative things that a company could do like ours have seen a widened bid-ask in this environment; however, it makes sense over time to have liquidity in the balance sheet to be able to look at those sorts of things if indeed the bid-ask narrows and becomes attractive. So, we would keep all options on the table and again, this is about playing aggressive offense where we can. In a way, Jeff, our timing was unfortunate; we executed a large acquisition and had a hung bridge loan in April and couldn’t have been in a worse position, and you fast forward and between announcing and closing the RMT transaction was accomplished in 10 months. We really need to capitalize on that good fortune and make sure that we're parlaying that into a bright future where we can invest for the long run.

Hey guys, good morning. What was the total Thermo King down on revenues for the quarter?

In the Americas, I think, Dave, it was down - …

This is down about 30% and EMEA down about 10%, 15%, I think it was.

Okay. Got it. And I think you guys had said that the total, you said something about mid-single-digit growth in commercial, was that for the total commercial business in the quarter?

We talked about the EMEA, I am sorry, the Americas number was up the mid-single digits, correct. EMEA was slightly down and that was really driven by the Middle East; actually, Europe was up. And Asia-Pacific was the hardest hit by the pandemic as it obviously hit there first, and it was down double-digits.

Right. And in global services, you mentioned it was weak across the board; what was that for globally just services for HVAC?

Yes, obviously, it was down in Asia-Pacific. Globally it just did not perform as well as we thought it should have. Actually, it was flat in the Americas, but again, we expect more out of that and we have had some disruption getting on job sites really in all aspects of the service business, whether it be service agreements, whether it be break-fix; we have had some disruption. But with that said, Steve, I want you to take away, we've also seen some opportunities with our intelligent services, and we've been a long-time getting buildings connected. We have over 20,000 buildings connected now and are really seeing the benefit there. Customers are really seeing the benefit of being able to have those buildings serviced remotely and diagnose if there's something wrong. As Mike said, indoor air quality in buildings is a very important aspect of our business; we're really good at it. There's a lot of science around it, and as office buildings around the world start ramping back up, our service techs are on call to make sure we could help our customers.

One more quick one, just on the earnings bridge. Kudos to you guys for giving some sub-segment detail. Mike, thanks for that. But you guys don't give the earnings bridge anymore. What was kind of price material inflation on a margin basis year-over-year this quarter?

Steve, this is Chris. We were positive on a price and cost basis on the margin bridge. And to your comments, I think that Margin Bridge has really served us well in the past when we've had, especially the last couple of years, higher tariffs and higher inflation. Consciously going forward, we want to make sure we can tell the story of what's happening on a quarterly basis. So, we want to make sure we do that without the confines of a bridge. But to your question, price cost was positive in the quarter; productivity was probably positive versus other inflation, although that's where we also saw some of the investment in our COVID-19 measures.

Hey, good morning, guys. Thanks for all the color. Mike, China back to flattish demand year-over-year is relatively quick. Can you give us more color on the type of demand you're seeing? Is it more the indoor air quality products and services buildings need to be serviced or is it more delayed larger orders coming back?

Yes, I'm going to hand that over to Dave here. But let me kick off just a thought going forward. Our business in China really is on institutional, large commercial equipment with the growing service business; that service business comprises a quarter to a third of our mix, which of course was heavily impacted. So, we recognize revenue when we ship like a chiller or we recognize revenue when we complete a service engagement and bill a client. There’s very little progress billing or percent complete accounting that would even it out. So, it would look outsized for us because we weren't shipping chillers. Conversely, the backlog of chillers to ship in China is fairly substantial. And I think what Dave will tell you is that we're seeing a return back to prior levels at this point.

Yes, Andrew, we have the incoming order rate for April; actually, as we're still rolling up the numbers here, looks like it's going to be a little bit favorable to last year; there's probably some pent-up demand there. I would tell you though that as we track our pipeline, and this is the orders that haven't yet been booked but are actively being quoted, the pipeline is actually starting to show positive movements as well and that's a really good indicator as to what future activity would be. We're still watching it, but April was a good sign, and well, certainly a lot of attention to it in the rest of the quarter.

So that's very encouraging. I did want to follow up on services. You mentioned that being flat in Q1 a little disappointing. Is services going to outpace the 20% decline that you're talking about for Q2 and do you see services starting to snap back as the economy begins to turn on, or is it too early to see that at this point?

Yes, No; it may be a little bit early to see that. But first of all, your first question, yes, we do see services outperforming the equipment in the second quarter, so it will not be down 20%. We expect that to be hopefully more in the flattish range. Your second question, do we see opportunities in services? Absolutely; one of the things that as we talked about our playbook in a downturn, we protect our expertise in service, particularly our service technicians. We're ring-fencing that to say that we’re not going to go cut costs there. We're protecting that because we know that as the economy snaps back and individuals start returning to the offices to work, indoor air quality is going to be super important, and how you're able to help those customers understand air quality and have solutions for them. We're really going to leverage our service business in that way.

Yes, Andy, I would say that clearly a service business is not an antidote to a pandemic, but it is an antidote to recession. As we move through pandemic concerns into whatever the new normal will be for building occupancy and services, we absolutely would expect to see as we have in every downturn—every recession—you're going to see capital extended. And here in particular, you'll have large commercial, large institutional customers looking at making sure that airflow, air changes, diffusion, dilution, and pressurization filters are all going to be in tip-top shape. So really, for us, that will require every technician we've got, and it will require more connected buildings because customers are going to want that service as opposed to people that don’t need to be in your building, right? I mean, there's no point in coming out to a facility if you don't need to if you can diagnose it first in advance and maybe even fix it remotely, which often we can do. That's going to be an opportunity. And that's a great way for us to deliver service at even higher margins than physically delivering services.

Hi, good morning. Maybe just the first question on the decremental margins. So understood that firm-wide, you're aiming for that or think you can hold the line at that sort of 30 percent-ish level like you had in Q1? But clearly, I think mix can play a massive role in swinging that around. Your Americas decrementals in Q1 were quite a bit higher than the gross margin, for example. So maybe help us understand what mix assumptions you have for the balance of the year and whether you are very confident that you can offset swings in mix with cost actions.

Yes, Julian. First of all, the Americas showed somewhat of a $40 million revenue differential. So the absolute dollars are relatively small for the size of the business. Regarding the detrimental, the first cause was not the mix with transport or the mix of service; it was really the response we took with regard to the COVID crisis. Just to give you a sense if you ever wonder if we actually walked the talk in terms of what we say about our values around safety, we always think about March being half of the quarter. And we always think about the last week of March being half of March. Therefore a quarter-over-quarter analysis would show that late March actually represented nearly 50% of the quarter. We actually pulled the end on the cord on March 23rd, shutting down all of our factories in Europe and the Americas, and prioritized only essential orders going into fighting COVID, which ranged from 10% to 15% of the orders. During that time, of course, we lost that absorption. But when we sent people home, we sent them home and topped up their pay to make sure they were paid their full wages; any gaps with applicable unemployment benefits were topped up. We made all planned wage increases around the globe for any hourly associate or service technician. We reclassified our medical plan to ensure that COVID testing and preventive care would incur no costs to employees, and that telemedicine visits would also be at no cost to our employees. We amended our 401(k) plan to allow people to take out up to $100,000 in delayed loan repayments for a year. We also provided backup childcare and elder care programs for employees, which came with minimal copays to relieve stress. Finally, we extended our employee assistance program with resources for financial, emotional, legal, and other hardships. All those things contributed to costs. The biggest cost, however, involved taking approximately 25,000 jobs and reconfiguring all the lines and work stations to ensure we had all the PPE in place before people came back to work. So, if you look at Asia and Europe, deleverage was in the teens, while in the Americas we had a small revenue decline of $40 million; I don't want anyone to read too much into that. Before we discuss cost cut strategies, which we have ready, we must prioritize doing the right thing, which is what we did and will continue to do, even if given the same decision again.

Thank you. That's reassuring to hear. Maybe just one quick follow-up. And this might be for Michael or Chris. On Slide 16, you've got the helpful scenarios laid out. If I look at, say, scenario one sales down about 15%, I would expect the decremental you've talked about. Maybe it's a 30% drop in EBIT or EBITDA, and it looks like in that scenario, the free cash flow decline is maybe a bit heavier than the operating profit. Just wondering if I have that right, and whether I did or not, what you’re assuming for working capital within those cash flow scenarios.

I’ll start, Julian, this is Mike. I would say that if you go back to 2009, we were three times the cash-to-net income ratio. So, we know how to extract cash from the business in a significant downturn. So, I would look for extraordinary operating cash flow in a down 25% scenario. Just referring back to 2009, you can expect a positive outcome there. So I'm not sure if that analysis that you’re doing would be correct. Chris, do you want to add to that?

Yes, I’ll add. There may be a small element of conservatism in the numbers as well, but we want to invest capital at the normal levels of 1% to 2% of revenues in both of those scenarios, Julian, whether the investments are for employees or capital or otherwise. So, we can certainly discuss this further offline, but I think that’s a reasonable scenario for us right now with a bit of conservatism.

Hi. Good morning. I wanted to go back to the service conversation and maybe find out how much of that business is really driven by contractual service versus needing to get onto the site and generating some type of spare part or something to drive the revenue.

Yes, John, that's a good question. On a contractual basis, our service business is about 30%. There is a wide array of different service contracts we manage, so some include parts, and some do not. Therefore, there is some parts demand that's generated from that 30%. Then you move into the break-fix world where it's broken; they give us a call, and we come out and fix it. Then you also have planned maintenance, where you'll proactively plan with the customer to do a major replacement or a major overhaul on a piece of equipment.

John, it breaks out to about even thirds on the service business. So, if you'd look at it that way.

Hi, guys. Good morning. Hope you can hear me, okay? Well, good morning. Thanks for the detail. It's super helpful, but I'm kind of intrigued by this whole indoor air quality theme overall. And I guess the question really is what did the building owners care? Is there a sense of urgency outside of obviously hospitals have always cared? But when you think of the other categories that you sell into is there - your phone's lighting up that people say, wow, we need to do a retrofit project here or is it just too early to really say?

Yes. Scott, it's too early to say, but we're looking at just sort of human behavior and in the lasting effects of what a pandemic would do to society and we see a little bit happening through our lens in China, although you can't draw exact parallels between the two. One thing for sure is that the ability to really monitor your indoor air quality and to design and make sure that from a maintenance perspective and all the controls and automation that go into making sure that it's effectively working, I think you're going to see sort of more density per square foot of all that and perhaps codes that in some parts of the world, which may have not been you know up to high standards might change going forward as well, as food transportation codes and standards. So probably when you get through this it puts an importance. And I think particularly as buildings become tighter and tighter in terms of their design, I am talking about the envelope of the building, it’s so critical to make sure that you’re having fresh air exchange in the building; a typical building might have half a dozen to dozens of 100% air changes in an hour. And the ability to make sure that’s happening and that you’re killing pathogens in your system, or you can, or pressuring appropriately or diffusing air, or diluting air is going to be even more critical. So I think it bears a lot of opportunity going forward. I mean it's hard to say; we did get through this right now, but I think the other round of it probably has more opportunity than not.

Hey, Jason, do we have another question? Okay. I don't know if anyone can hear us, but that'll wrap up our call for today. We'll be around for any questions that you may have, please feel free to reach out to myself or to Shane and we look forward to speaking with you soon. Thank you.